T.C. Summary Opinion 2011-119
UNITED STATES TAX COURT
VICTOR AND FRANCISCA ANI, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 20312-09S. Filed October 11, 2011.
Victor and Francisca Ani, pro se.
Jon D. Feldhammer, for respondent.
HAINES, Judge: This case was heard pursuant to section 7463
of the Internal Revenue Code in effect when the petition was
filed.1 Pursuant to section 7463(b), the decision to be entered
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended and in effect for the years
at issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure. Amounts are rounded to the nearest
dollar.
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is not reviewable by any other court, and this opinion shall not
be treated as precedent for any other case.
Respondent determined deficiencies in petitioners’ Federal
income taxes for 2005 and 2006 (years at issue) of $1,869 and
$15,325, respectively, and an accuracy-related penalty under
section 6662(a) of $3,065 for 2006. The issues for decision
after concessions2 are whether petitioners may deduct losses from
their rental real estate activity under the passive activity loss
rules of section 469 for the years at issue and whether
petitioners are liable for the accuracy-related penalty under
section 6662(a) for 2006.
Background
Some of the facts have been stipulated and are so found.
The stipulation of facts, together with the attached exhibits, is
incorporated herein by this reference. At the time petitioners
filed their petition, they resided in California.
Petitioners timely filed their 2005 and 2006 individual
Federal income tax returns. Petitioner Victor Ani (Mr. Ani)
worked as a barber, and petitioner Francisca Ani worked full time
as a nurse. Mr. Ani reported his barber shop income and expenses
2
Respondent concedes that petitioner Victor Ani materially
participated in the rental activities and thus may qualify for
the $25,000 offset provided by sec. 469(i). Respondent also
concedes that petitioners have elected to treat all of the rental
properties as one activity under sec. 469(c)(7)(A) (flush
language).
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on Schedules C, Profit or Loss From Business. He also received
Forms W-2, Wage and Tax Statement, for 2005 and 2006 for barber
services he provided to a nursing home in Clovis, California, and
a juvenile hall in San Leandro, California.
Petitioners also owned five rental properties, which Mr. Ani
managed. He negotiated leases, dealt with tenants, collected
rent, coordinated repairs, and paid bills associated with the
properties. Petitioners reported the rental property income and
expenses on Schedules E, Supplemental Income and Loss, and
deducted losses of $64,856 and $125,510 for 2005 and 2006,
respectively, on the basis of their claim that Mr. Ani was a real
estate professional pursuant to section 469(c)(7)(B).
To substantiate their claim that Mr. Ani was a real estate
professional, petitioners submitted three documents. Two of the
documents, which covered the years at issue, were prepared by
petitioners’ accountant using information Mr. Ani provided. The
first document purports to be a sampling of activities that Mr.
Ani performed in the management of the rental properties. The
second document sets out hours spent on barber activities versus
real estate activities for 2005 and 2006. According to the
second document, Mr. Ani spent a total of 1,377 hours on barber
activities and 956 hours on real estate activities in 2005 and a
total of 1,380 hours on barber activities and 886 hours on real
estate activities in 2006. The third document, prepared by Mr.
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Ani in anticipation of trial, purports to estimate the amount of
time Mr. Ani spent on barber activities and real estate
activities during the years at issue. The estimates inflate the
hours spent on real estate activities and conflict with the
information in the other two documents.
On May 27, 2009, respondent sent petitioners a notice of
deficiency for 2005 and 2006 which disallowed the losses from
petitioners’ rental real estate under the passive activity loss
rules of section 469. Petitioners filed a timely petition with
this Court.
Discussion
I. Passive Activity Rules
The Commissioner’s determinations in a notice of deficiency
are presumed correct, and the taxpayer bears the burden of
proving that the Commissioner’s determinations are incorrect.
Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933).
Taxpayers are allowed deductions for certain business and
investment expenses under sections 162 and 212. However, section
469 generally disallows the deduction of any passive activity
loss. A passive activity loss is defined as the excess of the
aggregate losses from all passive activities for that year over
the aggregate income from all passive activities for the year.
Sec. 469(d)(1). A passive activity is any trade or business in
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which the taxpayer does not materially participate.
Sec. 469(c)(1).
Rental activity is generally treated as a per se passive
activity regardless of whether the taxpayer materially
participates. Sec. 469(c)(2). However, the rental activities of
a taxpayer who is a real estate professional pursuant to section
469(c)(7)(B) are not treated as per se passive activities. Sec.
469(c)(7)(A)(i).
To qualify as a real estate professional, a taxpayer must
satisfy both of the following requirements:
(i) more than one-half of the personal services
performed in trades or businesses by the taxpayer
during such taxable year are performed in real property
trades or businesses in which the taxpayer materially
participates, and
(ii) such taxpayer performs more than 750 hours of
services during the taxable year in real property
trades or businesses in which the taxpayer materially
participates.
Sec. 469(c)(7)(B). For couples filing “a joint return, the
requirements of the preceding sentence are satisfied if and only
if either spouse separately satisfies such requirements.” Id.
Section 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed.
Reg. 5727 (Feb. 25, 1988), sets forth the requirements necessary
to establish the taxpayer’s hours of participation as follows:
The extent of an individual’s participation in an
activity may be established by any reasonable means.
Contemporaneous daily time reports, logs, or similar
documents are not required if the extent of such
participation may be established by other reasonable
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means. Reasonable means for purposes of this paragraph
may include but are not limited to the identification
of services performed over a period of time and the
approximate number of hours spent performing such
services during such period, based on appointment
books, calendars, or narrative summaries.
Although “reasonable means” may be interpreted broadly, a
postevent “ballpark guesstimate” will not suffice. Moss v.
Commissioner, 135 T.C. 365, 369 (2010) (and cases cited thereat).
Even if taxpayers fail to qualify as real estate
professionals under section 469(c)(7) and must therefore treat
losses from their rental properties as passive activity losses,
they may still be eligible to deduct a portion of their losses
pursuant to section 469(i)(1). Section 469(i) provides a limited
exception to the general rule that passive activity losses are
disallowed. A taxpayer who actively participates in a rental
real estate activity may deduct a loss up to $25,000 per year
related to the activity. The deduction is phased out as adjusted
gross income, modified by section 469(i)(3)(E), exceeds $100,000,
with a full phaseout occurring when modified adjusted gross
income equals $150,000. Sec. 469(i)(3)(A).
Petitioners contend that Mr. Ani satisfies the section 469
requirements for being a real estate professional. We disagree.
The three documents petitioners submitted in support of their
contention that Mr. Ani is a real estate professional contain
conflicting information. With respect to the estimates Mr. Ani
prepared, petitioners failed to provide underlying documentary
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evidence to substantiate the estimated hours. Additionally, the
estimates inflate the number of hours spent on the real estate
activities substantially over the hours shown on the other two
documents that Mr. Ani’s accountant prepared using information
Mr. Ani provided. The estimates are simply postevent ballpark
guesstimates to which we attach no weight.
With respect to the two documents Mr. Ani’s accountant
prepared, the first document was prepared as a sampling of the
types of activities that could take place but was not complete
enough to establish hours for each activity. The second document
provided sufficient detail with respect to hours spent on the
barber and real estate activities when coupled with Mr. Ani’s
testimony. According to the second document, Mr. Ani spent a
total of 1,377 hours performing barber services and 956 hours
managing petitioners’ rental properties in 2005, and 1,380 hours
performing barber services and 886 hours managing petitioners’
rental properties in 2006. Thus, Mr. Ani spent more time in 2005
and 2006 working as a barber than he did managing petitioners’
rental properties.
Accordingly, we find that Mr. Ani does not satisfy the first
part of the definition of a real estate professional under
section 469(c)(7)(B). That definition required Mr. Ani to
perform more than one-half of his personal services in trades or
businesses during the taxable years in real property trades or
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businesses in which he materially participated. He did not. As
a result, we find that Mr. Ani was not a real estate professional
under section 469(c)(7) for 2005 or 2006. Accordingly, we hold
that petitioners’ rental activities during those years were
passive activities pursuant to section 469(c)(2).
Even though we have held that petitioners’ rental activities
were passive, we still must consider whether petitioners are
eligible to deduct a portion of their real estate losses pursuant
to section 469(i)(1) because of Mr. Ani’s active participation in
the management of the rental properties. The active
participation standard is met as long as the taxpayer
participates in a significant and bona fide sense in making
management decisions or arranging for others to provide services
such as repairs. See Moss v. Commissioner, supra at 371; Madler
v. Commissioner, T.C. Memo. 1998-112. It is clear from the
record that petitioners wholly own the rental properties and that
Mr. Ani has personally been very active in managing the rental
properties. Moreover, respondent concedes that Mr. Ani
materially participated in real estate activities during the
years at issue. Accordingly, we hold that petitioners are
entitled to deduct a portion of their real estate losses pursuant
to section 469(i)(1). However, petitioners’ deduction may be
limited by the phaseout calculation under section 469(i)(3)(A).
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II. Accuracy-Related Penalty
Respondent determined that petitioners are liable for the
accuracy-related penalty under section 6662(a) for 2006. Section
6662(a) and (b)(2) imposes a 20-percent accuracy-related penalty
upon any underpayment of tax resulting from a substantial
understatement of income tax. An understatement is substantial
if it exceeds the greater of 10 percent of the tax required to be
shown on the return or $5,000. Sec. 6662(d)(1)(A).
Respondent bears the burden of production with respect to
petitioners’ liability for the accuracy-related penalty
determined in the notice of deficiency and must therefore produce
evidence that it is appropriate to impose that penalty. See sec.
7491(c); see also Higbee v. Commissioner, 116 T.C. 438, 446
(2001). Petitioners accurately reported their income on their
2006 Federal income tax return. However, petitioners were unable
to deduct losses claimed on Schedule E because of the passive
activity loss rules of section 469. Thus, respondent calculated
that petitioners understated their tax liability by $13,524.3
Petitioners had reported taxes of $199 on their 2006 return. The
amount of the understatement was substantial because it exceeded
the greater of: (1) 10 percent of the tax required to be shown
3
This amount will have to be recalculated in the Rule 155
computation depending upon the outcome of the sec. 469(i)(3)(A)
calculations.
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on the return for the taxable year, or (2) $5,000. Consequently,
respondent has satisfied his burden of production.
The accuracy-related penalty is not imposed, however,
with respect to any portion of the underpayment of tax if the
taxpayer can establish that he acted with reasonable cause and in
good faith. Sec. 6664(c)(1). The decision as to whether the
taxpayer acted with reasonable cause and in good faith depends
upon all the pertinent facts and circumstances. Sec. 1.6664-
4(b)(1), Income Tax Regs. Circumstances indicating that a
taxpayer acted with reasonable cause and in good faith include
“an honest misunderstanding of fact or law that is reasonable in
light of all of the facts and circumstances, including the
experience, knowledge, and education of the taxpayer.” Id.
Petitioners did not address their liability for the
accuracy-related penalty at trial or on brief, except for a
single sentence in their answering brief stating that they are
not liable for the accuracy-related penalty. Though they hired
an accountant, petitioners maintained no contemporaneous books,
logs, or records to substantiate the hours Mr. Ani purportedly
spent managing the rental properties. Given the circumstances,
we find that they did not act with reasonable cause and in good
faith, and therefore we hold petitioners are liable for the
accuracy-related penalty under section 6662(a) for 2006.
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In reaching our holdings, we have considered all arguments
made, and, to the extent not mentioned, we conclude that they are
moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.